REVIEWER
Finance can be defined as the science and art of managing
money.
• At the personal level, finance is concerned with
individuals’ decisions about how much of their earnings
they spend, how much they save, and how they invest
their savings.
• In a business context, finance involves the same types of
decisions: how firms raise money from investors, how
firms invest money in an attempt to earn a profit, and how
they decide whether to reinvest profits in the business or
distribute them back to investors.
Financial Services is the area of finance concerned with
the design and delivery of advice and financial products
to individuals, businesses, and governments.
• Career opportunities include banking, personal financial
planning, investments, real estate, and insurance.
• Managerial finance is concerned with the duties of the
financial manager working in a business.
• Financial managers administer the financial affairs of all
types of businesses—private and public, large and small,
profit-seeking and not-for-profit.
• They perform such varied tasks as developing a financial
plan or budget, extending credit to customers, evaluating
proposed large expenditures, and raising money to fund
the firm’s operations.
• The recent global financial crisis and subsequent
responses by governmental regulators, increased global
competition, and rapid technological change also increase
the importance and complexity of the financial manager’
s duties.
• Increasing globalization has increased demand for
financial experts who can manage cash flows in different
currencies and protect against the risks that naturally arise
from international transactions.
related and
Financial Analyst - prepares the firms financial plan and budgets.
Capital expenditures manager- evaluates and recommends proposed
long term investments.
Project finance manager- arrange financing for approved long term
ivestments.
Cash manager- maintains and control the firms daily cash balance.
Credit analyst/manager- administers the firms credit policy
Pension fund manager- oversees or manages the assets and liabilities
of the employees pension fund
Foreign exchange manager- manages specific foreeign operations.
GOALS OF THE FIRM- MAXIMIZE SHAREHOLDER WEALTH
SHARE PRICE MAXIMIZATION- Financial decision and share price
Profit maximization may not lead to the highest possible share price
for at least three reasons:
1. Timing is important—the receipt of funds sooner rather than later
is preferred
2. Profits do not necessarily result in cash flows available to
stockholders
3. Profit maximization fails to account for risk
• Stakeholders are groups such as employees, customers,
suppliers, creditors, owners, and others who have a direct
economic link to the firm.
• A firm with a stakeholder focus consciously avoids
actions that would prove detrimental to stakeholders. The
goal is not to maximize stakeholder well-being but to
preserve it.
• Such a view is considered to be "socially responsible."
Business ethics are the standards of conduct conduct or
moral judgment that apply to persons engaged in
commerce.
• Violations of these standards in finance involve a variety
of actions: “creative accounting,” earnings management,
misleading financial forecasts, insider trading, fraud,
excessive executive compensation, options backdating,
bribery, and kickbacks.
• Negative publicity often leads to negative impacts on a
Firm
Managerial Finance Function
• The size and importance of the managerial finance
function depends on the size of the firm.
• In small firms, the finance function is generally
performed by the accounting department.
• As a firm grows, the finance function typically evolves
into a separate department linked directly to the company
president or CEO through the chief financial officer
(CFO).
CORPORATE ORGANIZATION
-the general organization of a corporation and the finance function.
Managerial Finance Function:
Relationship to Economics
• The field of finance is closely related to economics.
• Financial managers must understand the economic
framework and be alert to the consequences of varying
levels of economic activity and changes in economic
policy.
• They must also be able to use economic theories as
guidelines for efficient business operation.
• Marginal cost–benefit analysis is the economic principle
that states that financial decisions should be made and
actions taken only when the added benefits exceed the
added costs
Managerial Finance Function:
Relationship to Accounting
• The firm’s finance and accounting activities are closely
generally overlap.
• In small firms accountants often carry out the finance
function, and in large firms financial analysts often help
compile accounting information.
• One major difference in perspective and emphasis
between finance and accounting is that accountants
generally use the accrual method while in finance, the
focus is on cash flows.s
• Whether a firm earns a profit or experiences a loss, it must
have a sufficient flow of cash to meet its obligations as
they come due.
Finance and accounting also differ with respect to decision
making:
– Accountants devote most of their attention to the collection and
presentation of financial data.
– Financial managers evaluate the accounting statements, develop
additional data, and make decisions on the basis of their
assessment of the associated returns and risks
Financial Activities- primary activities of the financial manager.
BALANCE SHEET-
*MAKING INVESTMENT DECISION (CURRENT ASSETS & FIXED ASSETS)
*MAKING FINANCIAL DECISIONS ( CURRENT LIABILITIES & LONF-TERM
FUNDS)
Governance and Agency:
Corporate Governance -
• Corporate governance refers to the rules, processes, and
laws by which companies are operated, controlled, and
regulated.
• It defines the rights and responsibilities of the corporate
participants such as the shareholders, board of directors,
officers and managers, and other stakeholders, as well as
the rules and procedures for making corporate decisions.
Individual versus Institutional Investors
• Individual investors are investors who own relatively small
quantities of shares so as to meet personal investment goals.
• Institutional investors are investment professionals, such as banks,
insurance companies, mutual funds, and pension funds, that are paid
to manage and hold large quantities of securities on behalf of others.
• Unlike individual investors, institutional investors often monitor
and directly influence a firm’s corporate governance by exerting
pressure on management to perform or communicating their
concerns to the
firm’s board.
Government Regulation
• Government regulation generally shapes the corporate
governance of all firms.
• During the recent decade, corporate governance has
received increased attention due to several high-profile
corporate scandals involving abuse of corporate power
and, in some cases, alleged criminal activity by corporate
officers.
The Agency Issue
• A principal-agent relationship is an arrangement in
which an agent acts on the behalf of a principal. For
example, shareholders of a company (principals) elect
management (agents) to act on their behalf.
• Agency problems arise when managers place personal
goals ahead of the goals of shareholders.
• Agency costs arise from agency problems that are borne
by shareholders and represent a loss of shareholder
wealth.
The Agency Issue:
Management Compensation Plans
• In addition to the roles played by corporate boards,
institutional investors, and government regulations,
corporate governance can be strengthened by ensuring
that managers’ interests are aligned with those of
shareholders.
• A common approach is to structure management
compensation to correspond with firm performance.
The Agency Issue:
Management Compensation Plans
• Incentive plans are management compensation plans
that tie management compensation to share price; one
example involves the granting of stock options.
• Performance plans tie management compensation to
measures such as EPS or growth in EPS. Performance
shares and/or cash bonuses are used as compensation
under these plans.
The Agency Issue: The Threat
of Takeover
• When a firm’s internal corporate governance structure is
unable to keep agency problems in check, it is likely that
rival managers will try to gain control of the firm.
• The threat of takeover by another firm, which believes it
can enhance the troubled firm’s value by restructuring its
management, operations, and financing, can provide a
strong source of external corporate governance.
CHAPTER2
Financial Institutions & Markets
Firms that require funds from external sources can obtain
them in three ways:
1. through a financial institution
2. through financial markets
3. through private placements
• Financial institutions are intermediaries that channel the
savings of individuals, businesses, and governments into
loans or investments.
• The key suppliers and demanders of funds are individuals,
businesses, and governments.
• In general, individuals are net suppliers of funds, while
businesses and governments are net demanders of funds.
• Commercial banks are institutions that provide savers
with a secure place to invest their funds and that offer
loans to individual and business borrowers.
• Investment banks are institutions that assist companies
in raising capital, advise firms on major transactions such as
mergers or financial restructurings, and engage in trading
and market making activities.
• The Glass-Steagall Act was an act of Congress in 1933
that created the federal deposit insurance program and
separated the activities of commercial and investment
banks.
– Repealed in the late 1990s.
• The shadow banking system describes a group of
institutions that engage in lending activities, much like
traditional banks, but these institutions do not accept
deposits and are therefore not subject to the same
regulations as traditional banks.
• Financial markets are forums in which suppliers of
funds and demanders of funds can transact business
directly.
• Transactions in short term marketable securities take
place in the money market while transactions in long-term
securities take place in the capital market.
• A private placement involves the sale of a new security
directly to an investor or group of investors.
• Most firms, however, raise money through a public
offering of securities, which is the sale of either bonds or
stocks to the general public.
• The primary market is the financial market in which
securities are initially issued; the only market in which the
issuer is directly involved in the transaction.
• Secondary markets are financial markets in which
preowned securities (those that are not new issues) are
traded.
MONEY MARKET
• The money market is created by a financial relationship
between suppliers and demanders of short-term funds.
• Most money market transactions are made in marketable
securities which are short-term debt instruments, such as
U.S. Treasury bills, commercial paper, and negotiable
certificates of deposit issued by government, business,
and financial institutions, respectively.
• Investors generally consider marketable securities to be
among the least risky investments available
• The international equivalent of the domestic (U.S.) money
market is the Eurocurrency market.
• The Eurocurrency market is a market for short-term bank
deposits denominated in U.S. dollars or other marketable
currencies.
• The Eurocurrency market has grown rapidly mainly
because it is unregulated and because it meets the needs
of international borrowers and lenders.
THE CAPITAL MARKET
• The capital market is a market that enables suppliers and
demanders of long-term funds to make transactions.
• The key capital market securities are bonds (long-term
debt) and both common and preferred stock (equity, or
ownership).
– Bonds are long-term debt instruments used by businesses
and government to raise large sums of money, generally
from a diverse group of lenders.
– Common stock are units of ownership interest or equity
in a corporation.
– Preferred stock is a special form of ownership that has
features of both a bond and common stock.
Broker markets are securities exchanges on which the two
sides of a transaction, the buyer and seller, are brought
together to trade securities.
Dealer markets are markets in which the buyer and seller
are not brought together directly but instead have their
orders executed by securities dealers that “make markets”
in the given security.
– The dealer market has no centralized trading floors.
Instead, it is
made up of a large number of market makers who are
linked
together via a mass-telecommunications network.
– The Nasdaq market is one example
As compensation for executing orders, market makers
make
money on the spread (bid price – ask price).
International Capital Markets
• In the Eurobond market, corporations and governments
typically issue bonds denominated in dollars and sell them
to investors located outside the United States.
• The foreign bond market is a market for bonds issued by
a foreign corporation or government that is denominated in
the investor’s home currency and sold in the investor’s
home market.
• The international equity market allows corporations to
sell blocks of shares to investors in a number of different
countries simultaneously.
The Role of Capital Markets
• From a firm’s perspective, the role of capital markets is to
be a liquid market where firms can interact with investors
in order to obtain valuable external financing resources.
• From investors’ perspectives, the role of capital markets
is to be an efficient market that allocates funds to their
most productive uses.
• An efficient market allocates funds to their most
productive uses as a result of competition among wealth-
maximizing investors and determines and publicizes prices
that are believed to be close to their true value.
• Securitization is the process of pooling mortgages or
other types of loans and then selling claims or securities
against that pool in a secondary market.
• Mortgage-backed securities represent claims on the cash
flows generated by a pool of mortgages and can be
purchased by individual investors, pension funds, mutual
funds, or virtually any other investor.
• A primary risk associated with mortgage-back securities
is that homeowners may not be able to, or may choose not
to, repay their loans.
Regulation of Financial Institutions and Markets:
Regulations Governing Financial Institutions
• The Glass-Steagall Act (1933) established the Federal
Deposit Insurance Corporation (FDIC) which provides
insurance for deposits at banks and monitors banks to
ensure their safety and soundness.
• The Glass-Steagall Act also prohibited institutions that
took deposits from engaging in activities such as securities
underwriting and trading, thereby effectively separating
commercial banks from
investment banks
• The Gramm-Leach-Bliley Act (1999) allows business
combinations (e.g. mergers) between commercial banks,
investment banks, and insurance companies, and thus
permits these institutions to compete in markets that prior
regulations prohibited them from
Entering
Regulations Governing Financial Markets
• The Securities Act of 1933 regulates the sale of securities
to the public via the primary market.
– Requires sellers of new securities to provide extensive
disclosures to the potential buyers of those securities.
• The Securities Exchange Act of 1934 regulates the trading
of securities such as stocks and bonds in the secondary
market.
– Created the Securities Exchange Commission, which is
the primary government agency responsible for enforcing
federal securities laws.
Business Taxes
• Both individuals and businesses must pay taxes on income.
• The income of sole proprietorships and partnerships is
taxed as the income of the individual owners, whereas
corporate income is subject to corporate taxes.
• Both individuals and businesses can earn two types of
income—ordinary income and capital gains income.
• Under current law, tax treatment of ordinary income and
capital gains income change frequently due frequently
changing tax laws.
Ordinary income is earned through the sale of a firm’s
goods or services and is taxed at the rates depicted in
• A firm’s marginal tax rate represents the rate at which
additional income is taxed.
• The average tax rate is the firm’s taxes divided by
taxable income.
• This exclusion moderates the effect of double taxation,
which occurs when after-tax corporate earnings are
distributed as cash dividends to stockholders, who then
must pay personal taxes on the dividend amount.
A capital gain is the amount by which the sale price of an
asset exceeds the asset’s purchase price.
CHAPTER 3
1. This are the practice and procedure guidelines used to
prepare and maintain financial record and reports:
authorized by Financial Accounting Standards Board (FASB).
-GENERALLY ACCEPTED ACCOUNTING PRINCIPLES(GAAP)
2. This are established by the International Accounting
Standard Board ( IASB) - INTERNATIONAL FINANCIAL
REPORTING STANDARDS
3. It provides a financial summary of a companys
operating results during a specified period.- INCOME
STATEMENT
4. It presents summary of a firms financial position at a
given point in time.- BALANCE SHEET
5. It reconcilles the net icome earned during a given year
and any cash dividends paid with the change in retained
earningd between the start and the end of thw year-
STATEMENT OF RETAINED EARNINGS
6. It provides a summary of the firms operating ,
investtment , and financing cash flows and reconciles them
with changes in its cash and marketable securities during
the period.-STATEMENT OF CASH FLOWS
7. It involves methods of calculating and interpreting
financial ratios to analyze and monitor the firms
performance . -RATIO ANALYSIS
8. ___Analysis is the comparison of the different firms
financial ratios at the same point in time; involves
comparing the firms ratios to those of other firms in its
industry or to industry averages - CROSS-SECTIONAL
ANALYSIS
9. ___ Is a type of cross sectional analysis in which the
firms ratio values are compared to those of a key
competitor or group of competitors that it wishes to
emulate-BENCHMARKING
10. ____analysis is the evaluation of the firms financial
performance over time using financial ratio analysis.-TIME-
SERIES ANALYSIS/TIME-SERIES
11. The ___ of the analysis is uses to dissect the firms
financial statements and to assess its financial condition.-
DuPont System
12. The financial Accounting Standard Board (FASB) is the
federal regulatory body that governs the sale and listing of
securities. -False
13. The income statement is a financial summary of the
firms operating results during a specified period while the
balance sheet is asummary statement of the firms financial
position at a given point in time .-TRUE
14. Generally Accepted Accounting Principles are
authorized by the Financial Accounting Standards Board
(FASB) - TRUE
15. The balance sheet is a statement which balance the
firms assets (what it owns) against its debt ( what it owes)-
FALSE
16. The statement of cash flows reconciles the net income
earned during a given year, and any cash dividends paid,
with the change in retained earnings between the start and
end of the year-FALSE
17. The Financial Accounting Standards Board (FASB)
standard No. 52 mandates that U.S based companies
translate their foreign -currency-denominated assets and
liabilities into dollars using the current rate method.- TRUE
18. Benchmarking is a type of cross sectional analysis in
which the firms in other industries , primarily to identify
areas for improvement . - FALSE
19. Ratio Analysis merely directs the analyst to potential
areas of concern; it does not provide conclusive evidence as
to the existence of a problem. -TRUE
20. Cross sectional ratio analysis involves comparing the
firms ratios to those of firms in other industries at the same
point in time.- FALSE
21. Due to inflationary effects, inventory costs and
depreciation write-offs can differ from their true values,
thereby distorting profits. -TRUE
22. Time- series analysis evaluates performance of firms at
the same point in time using financial ratios - FALSE
23. In ratio analysis , the financial statements being used
for comparison should be dated at the same point in time
during the year. - TRUE
24. The liquidity of a business firm refers to the solvency of
the firms overall financial position .- TRUE
25. The use of the audited financial statements for ratio
analysis may not be preferable because there may be no
reason to believe that the data contained in them reflect
the firms true financial condition. - FALSE
26. The liquidity of a business firm is measured by its ability
to satisfy its long-term obligations as they come due. -
FALSE
27. The current ratio provide a better measure of overall
liquidity only when a firms inventory cannot easily be
converted into cash. If inventory is liquid, the quick ratio is
a preferred measure of overall liquidity.- FALSE
28. Return on total assets (ROA) measure the overall
effectiveness of management in generating profits with the
owners investment in the firm. - FALSE
29. The financial leverage multiplier is the ratio of the firms
total assets to stockholders equity.- TRUE
CHAPTER 4
1. It is the primary ingredient in any financial valuation
model- CASH FLOW
2. The portion of the costs of fixed assets charged against
annual revenues overtime- DEPRECIATION
3. This category of cash flow is directly related to sale and
production of the firms products and services.- OPERATING
FLOWS
4. This category of cash flows is a cash flows that result
from debt and equity financing transactions; include
incurrence and repayment of debt , cash inflow from the
sale of stock and cash outflows to repurchase stocks or pay
cash dividends. - FINANCING FLOWS
5. This category of cash flows is cash flows associated with
purchased and sale of both fixed assets and equity
investment in other firms. - INVESTMENT FLOWS
6. The amount of cash flow available to investors( creditor
and owners) after the firm has met all operating needs and
paid for investment in net fixed assets ( NFAI) and net
current assets (NCAI). - FREE CASH FLOW
7. This begins with long term or strategic, financial plans
that in turn guide the formulation of short term or
operating plans and budgets- FINANCIAL PLANNING
PROCESS
8. This involves the preparation of the firms cash budget.-
CASH PLANNING
9. This involves preparation of pro forma statements -
PROFIT PLANNING
10. It is a statement of the firms planned inflows and
outflows of cash that is used to estimate its short term cash
requirements.- CASH BUDGET
11. It is prediction of the sales activity during a given period,
based on external and/ or internal data. - SALES FORECAST
12. This are project , or forecast , income statements and
balance sheets. - PRO FORMA FINANCIAL STATEMENT
13. It is a simple method for developing a pro forma
income statement- PERCENT - OF -SALES METHOD
14. It is simplified approach for preparing the pro forma
balance sheet under which the firm estimates the values of
certain balance sheet accounts and uses its external
financing as a balancing or plug figure.- JUDGMENTAL
APPROACH
15. Under the basic MACRS procedures, the depreciable
value of an assset is its full cost, including outlays for
installation.- TRUE
16. Free cash flow (FCF) is the cash flow a firm generates
from its normal operations; calculated as EBIT-
taxes+depreciation. - FALSE
17. The net fixed assets investment (NFAI) is defined as the
changed in the net fixed assets plus depreciation.- TRUE
18. In the statement of cash flows, the operating flows are
cash flows directly related to purchase and sale of fixed
assets- FALSE
19. Depreciation is considered to be an outflow of cash
since the cash must be drawn from somewhere. FALSE
20. The net current asset investment is defined as the
change in current assets minus the change in sum of the
accounts payable and accruals. TRUE
21. To asses whether any developments have occurred that
are contrary to the company financial policies, the financial
manager should pay special attention to both the major
categories of cash flow and the individual items of cash
inflow and outflow. - TRUE
22. The strategic financial plans are planned long term
financial actions and the anticipated financial impact of
those action . - TRUE
23. The financial planning process begins with short run or
operating plans and budget that in turn guide the
formulation of long run or strategic financial plans. - FALSE
24. Operating financial plans are planned short term
financial action s and the anticipated financial of those
action. TRUE
25. Cash budget is a statement of the firms planned inflows
and outflows of cash that is used to estimate its long term
cash requirement - FALSE
26. Cash planning involves the preparation of the firms
cash budget. Without adequate cash-regardless of the level
of profits -any firm could fail.- TRUE
27. The sales forecast , cash budget , and pro forma
financial statements are the key outputs of the short run
(operating) financial planning. FALSE
28. The number and type of intervals in the cash budget
depend on the nature of the business. TRUE
29. An internal sales forecast is based on the relationships
that can be observed between the firms sales and certain
key economic indicators such as the gross domestic product,
new housing starts or disposable personal income. FALSE
30. The pro forma statements provide the financial
manager with the amount , if any , of external financing
required ton support a given level of sales as well as a basis
for analyzing in advance the level of profitability.-FALSE
31. One basic weakness of the simplified pro forma
approach lies in the assumption that certain variables .-
TRUE
32. Net operating profit after taxes (NOPAT) represent the
firms earnings before interest and after taxes . TRUE
33. One basic weakness of the simplified pro forma
approach lies in the assumption that the firms past financial
condition is an accurate indicatr of its future- TRUE
34. It would be correcct to define operating cash flow (OCF)
as net operating profit and taxes plus depreciation. - TRUE